Why the VAT May Seem Good in Theory, but Is Bad in Reality

Simply stated, unless the 16th Amendment is repealed and replaced with a new provision forever barring the re-imposition of any taxes on income, a VAT inevitably would be a new source of revenue and become a money machine to finance ever-larger government.

In some sense, it’s a version of the national sales tax, except the revenue is collected on the “value added” at each stage of the production process rather than in one fell swoop when consumers make their purchases.

And it’s also conceptually similar to the flat tax. Both have one rate. Both have no double taxation. And both (at least in theory) have no special preferences and loopholes. The difference between a flat tax and the VAT is that the former taxes your income (only one time) when you earn it and the latter taxes your income (only one time) when you spend it.

In other words, the bottom line is that it is good (or, to be more accurate, less bad) to have a tax system with a low rate and no double taxation. And in the strange world of public finance economists, a system with no double taxation is called a “consumption-base tax.” And the flat tax, sales tax, and VAT all fit in that category.

So why, then, if supporters of limited government prefer a consumption-base tax over the internal revenue code, is there so much hostility to a VAT?

The answer is simple. We don’t trust politicians and we’re afraid that a VAT would be an add-on tax rather than a replacement tax.

Which explains why it’s better to simply turn the existing tax code into a consumption-base tax. After all, the worst thing that could happen is that you degenerate back to the current system.

But if you go with a VAT, the downside risk is that America becomes France.

There’s a story in today’s Wall Street Journal that illustrates why consumption-base taxation is both a threat and opportunity. Here are some introductory excerpts.

U.S. lawmakers on both sides of the aisle increasingly are finding appeal in an ambitious concept for overhauling the nation’s income-tax system: a tax based on consumption, a tool long used around the world. …As the name implies, consumption-style taxes hit the money taxpayers spend, rather than income they receive. One prominent feature of consumption systems is that they generally tax savings and investment lightly or not at all. That, in turn, encourages more investment and innovation, and ultimately more growth, many economists contend.

The reporter is wrong about consumption systems, by the way. Income that is saved and invested is taxed. It’s just not taxed over and over again, which can happen with the current system.

But he’s right that there is bipartisan interest. And he correctly points out that some politicians want an add-on tax while others want to fix the current system.

The tax-writing Senate Finance Committee is giving new consideration to the consumption-tax idea with the hope that its promised boost to economic growth would ease the way to a revamp. …Some of these proposals would have consumers pay another tax in addition to existing state and local sales taxes, while others would merely reshape the current system to tilt it more toward consumption. …Enactment of a broad-based federal consumption tax would align the U.S. with a global trend.

A Democratic Senator from Maryland wants to augment the current tax code by imposing the VAT.

Mr. Cardin introduced legislation last year to create a type of consumption tax known as a value-added tax and at the same time lower business taxes and scrap income taxes completely for lower-income Americans.

While some GOP Senators want to modify the current system to get rid of most double taxation.

Republicans on the working group also are interested in the concept, including a proposal put forward recently by GOP Sens. Marco Rubio of Florida and Mike Lee of Utah. That plan would make several changes to the tax code that would move the nation closer to a consumption-based system. …Many GOP members “believe that there are economic benefits to moving away from taxation of income and toward taxation of consumption,” a Senate aide said.

And the story also notes the objections on the left to consumption-base taxation, as well as objections on the right to the VAT.

Some liberals are concerned that consumption taxes affect poor people disproportionately, while unduly benefiting the rich, unless adjustments are made. For their part, conservatives fear that some types of consumption tax—particularly value-added taxes—would make it too easy to dial up government revenue collection.

So what’s the bottom line? Is it true, as the headline of the story says, that “Proposals for a consumption tax gain traction in both parties”?

Yes, that’s correct. But that’s not the same as saying that there is much chance of bipartisan consensus.

There’s a huge gap between those who want a VAT as an add-on tax and those who want to reform the current system to get rid of double taxation.

This doesn’t mean we shouldn’t worry about the prospect of an add-on VAT. As I warned last year, there are some otherwise sensible people who are sympathetic to this pernicious levy.

Which is why I repeatedly share this video about the downside risk of a VAT.

And you get the same message from these amusing VAT cartoons (here,here, andhere).

[…] but that downside risk is rather tame compared to the downside risk of a national sales tax or value-added tax, which is that politicians would pull a bait and switch, never get rid of the income tax, and then […]

[…] but giving politicians another source of revenue without permanently abolishing the income tax would be a tragic mistake. So when I heard that House Republicans were putting together a tax plan, I understandably was […]

[…] way, means no income tax. Nothing. No capital gains tax, either. The main source of revenue is a value-added tax, generally about 20 percent, along with a tax on business income, but only if a substantial share […]

[…] way, means no income tax. Nothing. No capital gains tax, either. The main source of revenue is a value-added tax, generally about 20 percent, along with a tax on business income, but only if a substantial share […]

[…] debate is that there are some normally rational people who are sympathetic to the VAT because they focus on theoretical issues and somehow convince themselves that this new levy would be good for the private […]

[…] which case we could degenerate back to the current system. That’s obviously bad news, but it’s not nearly as bad as what might happen with the Cruz and Paul plans. When the wrong politicians got back in charge, […]

At the end of the day the real question is; what is the government revenue to GDP ratio on a equal basis (corrected for national health /private health and other social programs that do not fall within “taxation”.

All countries need to set strict limits for the optimum and maximum government revenue that can be extracted from the economy, together with public borrowing limits. The system of taxation should be chosen according to the it’s efficacy in each particular economic environment.

Without political responsibility and accountability our “democratic” systems of government are destined to fail. That requires political reform and a curb on big money lobbying.

So tell me, Dan. Was my sainted grandmother wrong when she strongly advised me to never put all your eggs in one basket. Funding the federal government with basically just one type of tax goes against her sage(?) advice. I guess you believe that Congress can not be controlled, particularly with regard to spending? Throw all the bums out!!!